Fair Value vs Historic Cost Depreciation
When producing balance sheets for financial statements, companies are required to place a value on their assets. Doing so accurately is important, as under or overstating financial position can have costly consequences by leading to ill informed decision making.
It stands to reason that only when directors have accurate knowledge about their company’s finances, can they make informed and considered decisions.
In the main, there are two methods for valuing assets for financial statement purposes. These are the traditional Historic Cost Depreciation, and Fair Value approaches. The former takes the original purchase price and reduces it each year in either a straight line or by a reducing balance in order to calculate net book value (NBV). A Fair Value valuation on the other hand, seeks to identify the price at which the asset would be expected to realise, if it were actually sold. The definition of Fair Value given by the International Financial Reporting Standards is “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”
Marriott & Co have been providing Fair Value valuations for financial statement purposes for clients over many years. It is sometimes argued that Historic Cost Depreciation leads to a more ‘conservative’ valuation, but we don’t believe that this should be the objective. The clients who opt for a Fair Value approach feel the same way we do; that this is the path to choose if accuracy is the priority.
Whilst using Historic Cost Depreciation to calculate a net book value may be simpler, less time consuming and therefore potentially cheaper to ascertain, Fair Value accounts for a myriad of economic factors, each of which can have a significant impact on value, which Historic Cost Depreciation ignores. This is why the Fair Value process is able to produce a valuation that mirrors reality.
Condition of the asset, market trends, inflation, foreign-exchange rate factors, obsolescence, and technological advancement can each affect value significantly. Historic Cost Depreciation does not take account of all these factors, to say nothing of the fact that sometimes assets will increase in value over time.
Another facet of the Fair Value approach which our clients benefit from, is the potential for extra value on the balance sheet. This is achieved my establishing the fair value of each asset at the balance sheet date and reporting any surplus as a fair value reserve within shareholder funds. For businesses with a significant investment in plant and machinery, adopting the Fair Value approach will enhance the business’ financial reporting and overall value. Often, using Fair Value can reveal that the true value of an asset is far higher than the ‘book value’ generated by depreciating its historic cost. Added value on the balance sheet can make it easier for companies to raise investment or loan funds.
Providing an opinion on Fair Value requires an expert to give the matter careful consideration, as it is the more sophisticated approach. However, once this procedure has been established, revaluation is often less time consuming than the initial valuation, particularly if a desktop valuation is provided. This means that in subsequent years, the cost of producing a Fair Value valuation may be lower than on the first occasion.
We, and many of our clients, believe that Fair Value is the best approach for financial reporting.
Rich Cheeseman, Valuation Research Analyst, Marriott & Co.
Overtime Bidding – Hard Closing, Soft Closing and Extension Periods
Since Marriott & Co. started using Online Auctions, we have run the auctions with a “soft close” that is to say that there is overtime bidding, if a bid is received within the last ten minutes of a lot closing then the closing time of the lot will extend by ten minutes ad infinitum. This is different to a “hard closing auction” where the closing time is fixed and does not extend, used on sites such as eBay. The advantage of the soft close for both auctioneers and bidders is that it prevents “sniping” where bids are placed in the last seconds of the lot closing and bidders not having enough time to react. Roth and Ockenfels excellent study on Last-Minute Bidding in 2002 found that late bidding is surprisingly common with the following patterns found with hard closing lots:
1. 20% of all bidders submitted bids in the last hour.
2. 13% of all bidders submit their bids in the last five minutes.
3. 50% of all bids are submitted in the last five minutes.
4. 37% of lots had bids in the last minute.
5. 12% of lots had bids in the last ten seconds.
The soft closing of a lot effectively means that bidders, if paying attention, will never run out of time, only funds. Marriott & Co. currently use a ten-minute extension, which in the past has meant that lots scheduled to close at 3pm have ended up closing at 7.30pm. Whilst this maximises the realisation for the client and gives ample opportunity to bidders, it is also inconvenient for both bidders and the auctioneer for the closing of a sale to drag on for so long.
To remedy the above, going forward Marriott & Co. auctions will be reducing the overtime period from ten minutes to two minutes. Retaining the advantages of the soft close but also dramatically reducing the ability for the closing of a lot to drag on into the night, which can allow bidders to get distracted or simply bored. Bidders will still have sufficient time to act and react but the reduced period should also add a sense of urgency and allow bidders to focus on the task at hand.
John Stickland, Auction Manager, Marriott & Co.
Ensuring the Safe Removal of Assets After a Sale
When it comes to asset sales, the thrill of closing a deal can be exhilarating. However, once the ink has dried, it’s crucial not to overlook the often underestimated step of overseeing the safe removal of assets. At Marriott & Co., we understand the significance of this phase, ensuring that proper procedures are in place to protect both buyers and sellers.
1. Valuing Your Assets:
Before any sale process even commences, it’s essential to assess the value of your assets accurately. This step is vital to determine the fair market price, enabling you to negotiate a better deal with potential buyers. At Marriott & Co., our experts specialize in valuing business assets, helping you get the most out of your sale.
2. Proper Disassembly and Packaging:
The safe removal of assets involves more than just a forklift and a loading dock. It requires meticulous planning and execution. Our team requires that method statements are provided and ensures that all assets are disassembled, packaged, and loaded properly by competent contractors, to prevent accidents, damage and ensure safe transport. From industrial machinery to office equipment, we ensure each item is handled with care by your chosen contractors.
3. Compliance with Regulations:
Selling assets often involves navigating a web of regulations, including environmental standards, health and safety guidelines, and industry-specific rules. Marriott & Co. takes pride in our commitment to compliance. We have the expertise to ensure that all removal procedures align with relevant regulations, preventing potential accidents and legal pitfalls.
In conclusion, a successful asset sale doesn’t end with a handshake and a signed contract. To safeguard the personnel on site and your interests, and thereby maintain a positive reputation, overseeing the safe removal of assets is paramount. Marriott & Co. specializes in managing this critical phase, ensuring that proper procedures are in place to protect both buyers and sellers.
When you choose Marriott & Co., you’re not just selling assets; you’re securing a comprehensive solution that guarantees the safe and efficient removal of your valuable possessions.
Manish Gurung, Graduate Asset Surveyor, Marriott & Co.
UK car sales – is the Covid-19 hangover finally over?
Like countless other industries across much of the world, the UK market for new cars was decimated during the Covid-19 pandemic. Lockdowns and economic uncertainty crushed the demand for new cars, with Sky News reporting that new car sales fell 29% from 2019 to 2020, which represented the biggest annual slump since 1943 – when the industry was repurposed for the war effort. For long periods, the manufacturing of new cars all but stopped in the UK as factories were forced to close to alleviate the spread of the virus. There were other pandemic-related factors at play too, with supply chain disruption resulting in microchip and semiconductor shortages. These conditions manifested a £20.4bn loss in turnover.
However as is often the case, challenges to one industry can represent opportunities for another, and after a brief downturn, used car prices in the UK began to rise steadily due to a surge in demand. Naturally, with fewer new cars on the market, consumers were pushed towards used cars instead. Due to the nature of Covid-19, many consumers sought a safer alternative to public transport, and due to economic difficulty, some who would have been in the market for a new car were forced to tighten their purse strings and look for second-hand options instead. Rising prices represented uncharted territory for the used car industry. Historically, used car prices typically faced a steady month-by-month decline as the cars’ ages increased, and the technology available in new cars (not least safety features) steadily improved.
This boom seemed to continue through 2021, with auctioneer Motorway reporting a 300 percent increase in used car sales for the third quarter of 2021 compared with the same period the previous year. In January 2021, the average used car price on AutoTrader was £14,155. By January 2022, this figure had reached £18,067 – an increase of approximately 28%.
However, some reports suggest that this pattern began to change later in 2022, when used car prices started to fall. Soaring inflation, fuel costs and a nationwide cost of living crisis stretched consumers’ finances further. According to Indicata, a data and analytics firm, sales of used vehicles fell 13 percent in June 2022 compared to the previous year. As Covid-19 panic subsided, many consumers opted to sell their vehicles and return to public transport. Urvish Patel, an economist at the National Institute of Economic and Social Research stated that 2021’s supply chain constraints were starting to ease, giving the new car market a much-needed shot in the arm.
While prices have begun to correct themselves, it is not clear that the impact of Covid-19 has disappeared entirely. The exceptional circumstances of 2020-2022 are still affecting 2023 used car prices in the UK. Although many consumers have returned to public transport, the UK government reported in October 2023 that usage of buses, trains and the London Underground is still below pre-covid levels. The most striking examples being the London Underground and National Rail where usage is currently at 73% and 78% of pre-covid levels, respectively.
While new car registrations have been on the rise, there is still a shortage of used cars available because fewer ‘nearly-new’ vehicles are coming onto the market due to the aforementioned production disruptions. Karen Hilton, CEO of marketplace HeyCarUK said that ‘after two rollercoaster years, the used car market is steadying, but buyers still face strong used car prices for the foreseeable future’.
When I spoke to a used car dealer based in Farnham, they stated that prices were still clearly above pre-covid levels, to the tune of around 20%. This sentiment is in line with Marriott & Co.’s own findings – that depreciation rates for used cars are significantly lower this decade, compared to last.
Unfortunately, it seems that those who are currently in the market for a used car bargain, whom regrettably I can count myself among, may have to wait until at least 2024 to find one.
Rich Cheeseman, Valuation Research Analyst, Marriott & Co.
Third Party Risk Management
In just one week, two of our major and trusted suppliers have, for differing reasons, advised that their software platforms are closing and they can no longer supply services to us.
This is a blow to say the least, as their services have supported our business over many years, helping to enable the efficient and comprehensive service that we provide to our clients. We were at least very grateful to hear that our client account provider Metro Bank appears to have been saved, as to add a third supplier to the list of ‘casualties’ would have been even more disruptive!
The implementation of our third party risk management plans is now in full flow and we aim to use this ‘crisis’ as an opportunity to facilitate more efficient working procedures going forward, to benefit our clients.
The reliance, and therefore the risk, that we all have on third party owned software is huge, particularly perhaps for SME’s who cannot justify running two systems to cover the risk should one system fail, or employing a Risk Management Company to assist. Even with ‘go-to’ back-up systems in place, one must perform up-to-date, pre-and post-contract due diligence which of course all take up considerable administrative time and resources.
However, it does make sense to spend this time researching and implementing the correct systems that will form a crucial part of one’s business, hopefully for years to come.
Judith Campbell, Director of Disposals
Justification of the reducing balance approach to depreciation
Marriott & Co. have long espoused that, other than the early part of its useful life, which is when the value of machinery typically decreases most rapidly (the old adage that once you drive a new car off the forecourt it loses around 20% of its value is, perhaps, not as far from reality as one might expect), the majority of plant & machinery’s market value tends to depreciate at a relatively predictable rate per year until it hits a residual value at the end of its economic life. It has been demonstrated by numerous studies that plant & machinery usually loses less and less value each year of its life (i.e. the decrease in value, in monetary terms, reduces each year).
Thus, adopting a reducing balance depreciation scale for machinery valuations is generally viewed as an accurate estimator of market value. For example, a machine that depreciates at a rate of 10% a year on a reducing balance depreciation scale, will (after year 1) theoretically lose 10% of its market value each year, e.g. a machine worth £70,000 may depreciate by £7,000, to £63,000, in the course of one year, and then the following year it may depreciate by £6,300 (i.e. 10% of £63,000) and so on.
It is our understanding that many machine buyers, in various industries, accept this approach as a good “rule of thumb” (i.e. as an average) subject of course to other specific factors affecting market value and depreciation rate, such as condition, level of usage and obsolescence.
However, having long analysed auction results within this reducing balance paradigm, and calculated average yearly depreciation rates for numerous different manufacturers, types of machines and general categories of asset, Marriott & Co’s director of valuations Tom Allman MRICS, was interested to consider other types of analyses and was open to the data suggesting that we should vary our approach.
Tom, therefore, employed the assistance of his son (on his work experience at Marriott & Co.), to analyse numerous auction results by plotting onto a scatter graph, the percentage of its new replacement cost that a type of machine realised (on the Y axis) against the age of the machine when sold (on the X axis). We did this for fourteen different types of machine from a range of different industries, plotting enough auction results onto the scatter graphs to enable us to draw a curve of best fit indicating each type of machine’s typical depreciation profile and, in turn, we were able to form a bespoke depreciation table for each type of machine analysed.
The results, when analysed, were remarkably consistent!
Pretty much every type of machine analysed showed an extremely low variation in the yearly depreciation rate and it generally varied within 1 or 2% of the average depreciation rate that we had already derived from previous analysis. The conclusion, therefore, could only be that Marriott & Co’s (and other valuers’) current ‘market evidence based DRC approach’ is a sound valuation approach and that, save for the early part of its useful life, when the value drops considerably more than the average depreciation rate, thereafter, adopting a suitable reducing balance depreciation rate (ideally formed with reference to market evidence) is the best way of predicting the market value of a machine based on its age and its new replacement cost.
When we were approached by a distressed bespoke London distillery, Marriott & Co.’s marketing team went on the hunt for a buyer of its exclusive brands.
Having negotiated with several interested parties we successfully sold the brand names, recipes and other intellectual property to a major online wine and spirit retailer who are looking to move the brands forward.
We also managed the successful sales of the distillery equipment and bonded alcoholic stock.
Today’s Printing Industry
Since our founder, Mr Marriott, began his surveying life specialising in the printing industry, Marriott & Co. has witnessed a slow decline in the global printing industry.
Long life heavy-duty lithographic printing presses (and other traditional printing equipment) have been replaced with modern digital printing machines, including toner and inkjet machines, which typically depreciate very quickly and become obsolete within a few years.
We had the pleasure last spring of valuing the excellent modern machinery at two different digital printing businesses, and we continue to receive more corporate enquiries from printing businesses than any other sector.
So, whilst the printing industry has shrunk from its ‘hey day’, we are hopeful the decline has plateaued and the demand for printed matter will remain at a decent level to ensure the continuation of what we consider to be a noble art form.
Successful sawmill sale
During the pandemic we were instructed by a Director, looking forward to retirement, to dispose of his esteemed sawmilling equipment and stock.
Once we had catalogued over 370 lots of machinery and wood flooring the marketing began. With 500 new bidders registered we suspected our targeted marketing would be successful and we were right.
13,750 bids later, the sale finally closed at 7.30pm after over five hours of bidding extensions and the total realisation surpassed all our expectations.
When a flying school in the south of England went into liquidation Marriott & Co. were asked to assist with a sale of the school’s assets which included a 1980 Cessna F152 aeroplane.
Our client being an expert in the field, noted that the training goggles in our sale were in fact foggles, used to simulate foggy conditions for the wearer!
With bespoke and tailored marketing, the result from our online auction exceeded all expectations.
For further information about our valuation and disposal services, please call us on 01252 712 083.